The Hedgeweek Interview: Unearthing and backing emerging talent: Edward Horner, Managing Director, Eden Rock Capital Management

Edward Horner outlines the investment process and recent developments at Eden Rock Capital Management, which focuses on asset-based lending funds.


Eden Rock Capital Management was founded in December 2001 by James Matthews, Horner and Santo Volpe, who had worked together for a number of years prior to establishing the firm.


The Mayfair-based firm now has 13 full time employees and advises on assets in excess of USD 700 million, spread across four funds of hedge funds as well as several institutional managed accounts.


The backgrounds of the key executives at Eden Rock are as follows:


• James Matthews, CEO, is a qualified trader on Eurex, OMLX and the International Securities Exchange (ISE) of New York. He joined Spear, Leeds & Kellogg in September 1995 and worked on the London International Financial Futures Exchange. In 1997 he went with Nordic Options Ltd, which de-merged from Spear, Leeds & Kellogg where he became the senior equity options trader. In June 2000 James Matthews left Nordic and founded Eden Rock Securities and other companies within the Eden Rock group.


• Santo Volpe, CIO, has over 15 years experience in the financial markets, starting as a US Treasury Bond options market maker in Chicago. He moved to London in 1991 to trade interest rate options for Cresvale Ltd where he eventually became the head of proprietary trading for the Futures and Options Group (taken over by Refco in 1995). Santo Volpe advised and assisted in setting up several proprietary trading operations and hedge funds in Europe, the United States and the Far East. He has managed portfolios comprising all types of asset classes, debt instruments, derivatives and physical commodities both in the listed markets as well as OTC. Volpe (BA Northwestern, MSc University of London) holds an FSA General Representative qualification and a US Series 3 qualification.


• Edward Horner, Managing Director, first gained experience of the financial markets aged 18 while working on the London International Financial Futures Exchange for Alpha Financial Futures Ltd. After graduating from Newcastle University with an honours degree, he joined Merrill Lynch International Bank Ltd. He became the youngest Financial Consultant in the London office of the International Private Client Group and was made a partner of the largest team in Europe, where he advised clients with combined assets in excess of USD 2 billion on their global investment portfolios, comprising both traditional and alternative asset classes.  Edward resigned from Merrill Lynch in 2001 to establish Eden Rock Capital Management with Santo Volpe and James Matthews.


• David Moore, Head of Portfolio Construction, has over 20 years experience in the financial markets including international bonds, equities, asset allocation and alternative assets. He joined Eden Rock Capital Management in October 2003. His responsibilities include manager analysis, portfolio construction and risk management. Prior to joining Eden Rock Capital Management he was CEO of Global Fund Analysis, a hedge fund research and consulting company. He began his career at Morgan Grenfell & Co in 1978 and and has held board level positions at Midland Montagu Asset Management, BZW Asset Management and Credit Lyonnais Rouse.


HW: What is your current AUM and investor profile?


EH: The firm currently advises on allocated assets in excess of USD 700 million across all portfolios with institutional investors accounting for more than 50% of this figure.


HW: What are your funds?


EH: We currently advise four funds of hedge funds, as follows:


• Solid Rock Fund Limited (USD, EUR, GBP, CHF) (Offshore/US onshore): The Solid Rock Fund is a multi-strategy, globally diversified fund of hedge funds that aims to be uncorrelated to the major stock and bond indices.  The target annual return of the Fund is 10% with target annual volatility less than 5%.  The Fund is subject to monthly liquidity with no lock-up period.  The minimum investment is USD 100,000 or currency equivalent.  The Solid Rock Fund does not use portfolio leverage. 


• Eden Rock Fund Limited (USD, EUR, GBP, CHF) (Offshore/US onshore): The Eden Rock Fund is a highly diversified, multi-strategy, alternative investment fund that aims to achieve a consistent return - uncorrelated to equity and bond markets.  The fund employs leverage on a variable basis provided by KBC of up to 300%.  The target annual net return is 18% to 20% with target annual volatility of less than 8%.  Subscriptions are monthly with quarterly redemptions.  The minimum investment is USD 100,000 or currency equivalent.  The Eden Rock Fund was launched on January 2 2004.


• Eden Rock Finance Fund LP (USD) (US onshore): The Eden Rock Finance Fund is a fund of asset based lending/credit funds.  US based Sky Bell Asset Management are Co-General Partners on the fund.  The goal of the fund is to achieve a superior investment return on a risk-adjusted basis. The fund employs leverage on a variable basis provided by Fortis and KBC of up to 150%.  The target annual return is 12 to 15% with a target volatility of less than 3.  The minimum investment is USD 500,000 or currency equivalent.  The Eden Rock Finance Fund LP was launched on August 2 2004.


• Eden Rock Structured Finance Fund Limited (USD, EUR, GBP, CHF) (Offshore): The Eden Rock Finance Fund is a fund of asset based lending/credit funds.  The goal of the fund is to achieve a superior investment return on a risk-adjusted basis. The fund employs leverage on a variable basis provided by KBC of up to 150%.  The target annual return is 12 to 15% with a target volatility of less than 3.  The minimum investment is USD 100,000 or currency equivalent.  The Eden Rock Structured Finance Fund Ltd was launched on November 2 2004.


HW: Have there been any recent events in the funds?


EH: The Eden Rock Finance Fund celebrated its first anniversary in July 2005.  Since inception, this fund of asset based lending funds has produced 100% positive months, a Sharpe Ratio of 8.52 and an annualized return of +11.42%.  In 2005 the Fund is +7.34% YTD.  Eden Rock are yet to experience a down month across any of their four portfolios of asset-based lending funds and both offshore and onshore funds are open to new investment. 


The firm's first fund, the Solid Rock Fund, now has more than three years track record.  Since its inception in July 2002, this unleveraged, niche fund of funds has produced an annualized return of 8.50% with a Sharpe Ratio of 2.54%.  In 2005 the Fund is +5.64% YTD.  The Fund is subject to monthly liquidity, is open to both offshore and onshore US investors, with multiple currency classes available.


HW: Have there been any recent changes/additions to the management team.


EH: Eden Rock has added a number of new staff over the summer.  Andrew Kinsey-Quick, previously with Asset Alliance, became the sixth member of the Investment Committee in July and Nicola Steele recently joined as COO from Fortis.  We are now 13 strong, with several further hires imminent.


HW: What is your investment process?


EH: At Eden Rock, all investment decisions are taken on a unanimous basis by our six-person investment committee.


• ER utilizes both a top down and bottom up approach throughout the entire portfolio management process.  Quantitative and qualitative analysis ensures that the optimal risk-return characteristics, such as low Beta, low correlation and high Alpha, are achieved and maintained in a tightly controlled framework.  Managers are selected within a diversified portfolio where inter-correlation amongst strategies and managers plays as important a role as the return characteristics on a stand alone basis.


• ER screens and selects hedge fund managers across a diverse range of strategies.  Typically, ER does not invest in managers that have not been met in person.  ER conducts regular on-site visits with managers as part of the due diligence and continuous monitoring process.  Optimal diversification is achieved by investing in a minimum of 20 funds in no less than 10 different investment strategies.


• ER has developed an internal Manager Evaluation Database to assess and monitor the quality of managers interviewed.  An in-depth analysis across various evaluation criteria is created after each manager visit.


• The asset allocation and manager selection process combines input from qualitative and quantitative analysis, as well as investment market intelligence.  ER captures timely financial data and market intelligence to enable the investment team to search for hedge funds with excellent risk-adjusted returns and to identify new, attractive managers on an ongoing basis.


HW: What are your due diligence procedures?


EH: ER examines three specific aspects of each manager as part of the due diligence process, as follows:


1) Investment Disciplines: The manager must have clear and achievable investment objectives with a proven track record of consistent returns and acceptable levels of volatility.  The managers are also required to have effectively managed market risk with appropriate in-house risk management policies.  The strategy needs to be supported by a market with no immediate capacity constraints.  Transparency regarding past failures is essential.  The managers must control their use of leverage in a prudent manner and within pre-determined guidelines as set out in the investment philosophy of the fund.


2) Investment Operations: ER requires managers to provide externally audited financial statements to demonstrate legitimate financial reporting.  It is seen as essential for managers to be personally significantly invested in the funds they manage.  ER evaluates the quality of management teams by checking references, checking with the relevant regulatory body and also using market contacts to gain further intelligence on the background, integrity and ability of each manager.   Key man risk evaluation is an essential part of the due diligence process.  Potential conflicts of interest (eg business ownership) are also considered.


3) Risk Control Disciplines: Managers should be governed by explicit risk control guidelines (e.g. stop-loss) and sell disciplines (e.g. profit taking), which are implemented continuously.  The managers are required to demonstrate the capability to use protective measures against market downturns, such as disaster insurance when appropriate.  ER closely monitors exposure to third party risk and ensures that the liquidity of funds is consistent with their underlying assets.


HW: How many funds are in your portfolios?


EH: The Solid Rock Fund has 25 funds, The Eden Rock Fund has 54 funds, The Eden Rock Finance Fund has 32 funds, and the Eden Rock Structured Finance Fund also has 32 funds.


HW: What makes a hedge fund manager special enough for you to select him?


EH: There are five factors, as follows:
• An 'Edge'
• First class references (Both supplied and independent)
• Comprehensive risk control procedures
• Sound operational infrastructure
•    Credible track record.


HW: What are your criteria for removing managers from the fund?


EH: We have two sets of criteria, manager-specific and portfolio-specific:
1) Manager-Specific:


• The manager fails to deliver expected returns or significantly underperforms, or outperforms the strategy peer group
• The manager violates the risk control parameters required for the continuous qualification within ER's FOF programs
• The manager experiences significant organizational changes - such as loss of key personnel or dramatic increase in AUM.
The above circumstances will result in the immediate increase in frequency of communication with the manager to weekly, or daily basis.  If the manager fails to satisfy ER's enquiries, the investment will be terminated.


2) Portfolio-Specific:


• Changes in the macro environment causing a particular strategy to fall out of favour. 


HW: How many managers do you have on the substitutes' bench?


EH: There are currently 23 managers on the approved list.


HW: What trends do you foresee this year?


EH: We predict the current trend of investors seeking 'alternatives to alternatives' to gather pace.  As mainstream hedge fund strategies become increasingly crowded and inevitably correlated - Eden Rock foresees that greater focus will be placed on new and emerging strategies, such as asset based lending.


As a specialty funds of hedge funds manager, Eden Rock is well placed to differentiate its products from the competition and cope with this particular challenge.


HW: Some funds of funds have complained that managers are not taking enough risks in the current environment - what are your views on this, and on risk in general?


EH: There is such a broad range of funds available to invest in that it is really up to the fund of funds manager to ensure they are comfortable with the level of risk being taken by the underlying managers at all times.  This can only be achieved by gaining a thorough understanding of the philosophy and strategy of a manager and then via continuous monitoring, on an intra-month basis where possible.


At Eden Rock, before allocating to any manager, the fund is categorised according to expected risk/return parameters.  If those parameters are breached, then a conference call, or a manager meeting is triggered in order to understand why the manager has performed in an unexpected way.  Eden Rock monitors style drift closely - both at the fund level, as well as the fund of fund level.


HW: Are investors' expectations moving upwards and how do you deal with this?


EH: Yes - inevitably as the industry matures and competition increases, investors are becoming more and more demanding.


At Eden Rock, we intend to continue to build our team by attracting the best available people.  We also intend to remain focused on unearthing and backing talented managers early, whilst avoiding swollen managers operating in crowded spaces.


HW: Are you planning any further launches this year?


EH: No - but we are likely to launch our next fund in Q1 2006.


 


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